Optimal Risk Classification with an Application to Substandard Annuities

Gatzert N, Schmitt-Hoermann G, Schmeiser H (2012)

Publication Language: English

Publication Type: Journal article, Original article

Publication year: 2012

Journal

North American Actuarial Journal Society of Actuaries

Publisher: Society of Actuaries

Book Volume: 16

Pages Range: 462-486

Journal Issue: 4

DOI: 10.1080/10920277.2012.10597643

Abstract

Substandard annuities pay higher pensions to individuals with impaired health and thus require special underwriting of applicants. Although such risk classification can substantially increase a company's profitability, these products are uncommon except for the well-established U.K. market. In this paper we comprehensively analyze this issue and make several contributions to the literature. First, we describe enhanced, impaired life, and care annuities, and then we discuss the underwriting process and underwriting risk related thereto. Second, we propose a theoretical model to determine the optimal profit-maximizing risk classification system for substandard annuities. Based on the model framework and for given price-demand dependencies, we formally show the effect of classification costs and costs of underwriting risk on profitability for insurers. Risk classes are distinguished by the average mortality of contained insureds, whereby mortality heterogeneity is included by means of a frailty model. Third, we discuss key aspects regarding a practical implementation of our model as well as possible market entry barriers for substandard annuity providers.

Authors with CRIS profile

Nadine Gatzert Lehrstuhl für Versicherungswirtschaft und Risikomanagement

Involved external institutions

Münchener Rückversicherungs-Gesellschaft (Munich Re) DE Germany (DE) Universität St.Gallen CH Switzerland (CH)

How to cite

APA:

Gatzert, N., Schmitt-Hoermann, G., & Schmeiser, H. (2012). Optimal Risk Classification with an Application to Substandard Annuities. North American Actuarial Journal, 16(4), 462-486. https://dx.doi.org/10.1080/10920277.2012.10597643

MLA:

Gatzert, Nadine, Gudrun Schmitt-Hoermann, and Hato Schmeiser. "Optimal Risk Classification with an Application to Substandard Annuities." North American Actuarial Journal 16.4 (2012): 462-486.

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